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Taxes and Development: India vs. China

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Taxes and Development: India vs. China Roger Gordon UCSD Taxes and Economic Growth: India vs. China What is the role of tax structure in economic growth in India? – PowerPoint PPT presentation

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Title: Taxes and Development: India vs. China


1
Taxes and DevelopmentIndia vs. China
  • Roger Gordon
  • UCSD

2
Taxes and Economic Growth India vs. China
  • What is the role of tax structure in economic
    growth in India?
  • Evolution of tax structures remarkably similar to
    that in China
  • Surprising given very different political systems
  • Objective of presentation
  • Lay out similar development of tax structures
    during the reforms in the two countries
  • Suggest a story to explain the observed interplay
    between taxes and economic reforms

3
Pre-reform Economies Very Similar
  • Initial per capita GDP
  • China 175 in 1979
  • India 215 in 1991
  • Dominant role for SOEs in both countries, with a
    particular focus on heavy industry
  • Allocation decisions subject to direct government
    controls
  • Minimal international trade or FDI
  • Tax system had little allocative role

4
Initial Reforms
  • Relax government licensing restrictions and other
    direct controls
  • Relax controls over allocation of credit
  • Cut tariff rates and nontariff barriers
  • Relax controls over exchange rate and FDI
  • Outcome after 14 years of reform
  • China GDP pc grew from 175 to 536
  • India GDP pc grew from 215 to 548

5
National taxes at beginning of reforms
CHINA INDIA
Corporate Tax 55 rate 50 to 55 rate
Excise Taxes High and variable rates High and variable rates
6
High Tax Rates on a Narrow Base
  • Revenue only from SOEs in China
  • Mainly from large industrial firms in India
  • Excise taxes confined to manufacturing
  • Yet manufacturing only 16 of GDP (1991)
  • 67 of corporate tax from manufacturing
  • 40 of revenue from SOEs

7
Policies Used to ProtectNarrow Tax Base
  • Protect heavy industry with tariffs. In India,
    average effective rate was 75 in 1990 (though
    reforms cut it to 15 at present)
  • Provide cheap credit to highly-taxed firms
  • Restrict hiring and firing of workers in SOEs
  • Direct controls on entry and investment in other
    sectors license, permit, quota Raj
  • Highly taxed industries plausibly larger, rather
    than smaller on net, due to tax distortions

8
Reforms Relax Controls
  • When relax controls, resources (and accounting
    profits) shift to low-taxed sectors
  • Major drop in the role of SOEs, from 68 of
    paid-in capital in 1992 to 28 in 2002
  • Drop in size of heavy industry, e.g. capital good
    production falls from 25 to 7 of GDP
  • Expansion in size of (lightly taxed) service
    sector
  • Given large tax distortions, reallocation not
    necessarily an efficiency gain

9
Resulting Fall in Tax Revenue
  • In China,
  • corporate tax revenue fell from 7.8 of GDP in
    1985 to 1.5 in 1993
  • Total nontariff revenue fell from 20.5 to 11.5
  • In India,
  • excise tax revenue fell from roughly 8.4 of GDP
    in 1991 to 7.7 by 2004
  • But corporate revenue increased from 0.9 to 2.3
  • nontariff revenue up from 12.0 to 13.4 of GDP
  • Likely reason for difference is improved tax
    enforcement in India

10
Further Economic Reform Requires Tax Reform
  • With relaxed controls, narrow tax base creates
    major distortions
  • Either limit relaxation of controls to preserve
    some tax revenue and to limit misallocations, or
    undertake major tax reform
  • China did try a retrenchment in 1988-91, but
    political and economic costs too high

11
Both Countries Undertook a Major Tax Reform
  • After 15 years of reform, both countries largely
    replaced excise taxes with a VAT
  • 17 rate in China
  • 16 rate in India
  • Both countries broadened the tax base for
    indirect taxes
  • China imposed national taxes on non-SOEs
  • India expanding excise tax base to include
    services and wholesale sector

12
  • Both countries cut the corporate tax rate to 33
  • Growing importance of personal income tax in both
    countries, capturing some income from informal
    sector
  • But while easy to cut rate on heavy industry,
    hard to increase effective tax rate elsewhere
  • Revenue in China fell further, from 12.3 in 1993
    to 10.1 in 1996
  • With improvements in enforcement, though, revenue
    later grew to 17.7 in 2004

13
Tax Structure Now More Compatible with a Market
Economy
  • Firms now face closer to neutral tax incentives
    in allocation decisions
  • With revenue largely unaffected by allocation,
    government finally has a fiscal incentive to
    fully support pro-market policies
  • In China, reforms followed by rapid and
    consistent economic growth
  • In India, a concern that national revenue still
    comes largely from manufacturing, plus some from
    service sector

14
Taxation by State and Local Governments
  • If only firms mobile, incentives neutral if
    collect same taxes per resident, regardless of
    which firms enter
  • Effective tax rates varied dramatically by type
    of firm
  • In China, tax on profits and sales of local firms
  • In India, excise taxes at variable rates on local
    firms
  • Agriculture and service sector very lightly taxed

15
Tax Competition
  • Incentive to protect heavily taxed firms from
    competition from other locations
  • In China, local governments encouraged entry in
    heavily taxed industries by providing valuable
    inputs and cheap credit
  • In India, tax competition undermines revenue
    collection

16
Implications of Low Tax Revenue
  • Poor quality of public utilities immediately
    threatens further growth
  • Poor quality education and health care undermines
    longer run growth
  • Average education is only two years
  • Only 35 of age group enrolled in secondary
    school
  • One third of children have low birth weight

17
What to Do?
  • Hope tax revenue improves
  • Chinas revenue has indeed improved gradually,
    growing from a low of 10.1 of GDP to 17.7 now
  • But the economic costs of waiting can be very
    high
  • Borrow against future tax revenue. But current
    deficits already 10.3 of GDP
  • Increased use of user fees, perhaps with private
    provision?
  • Key response in China, particularly for roads,
    education, health, telecom
  • Problem that poor may do without. Use available
    budget to subsidize purchase by the poor?

18
Is problem low revenue or poor incentives to
provide services?
  • Funding for state governments not THAT low
  • State revenue plus transfers in India in 2002 was
    9.7 of GDP
  • SL current expenditures in U.S. were 12.9 of
    GDP
  • But current figure for China is 13 of GDP, yet
    problems remain severe there
  • Incentives to provide services seem poor
  • Voice Key difference from China. But provides
    weak oversight
  • Exit But mobility across States low due to
    language and cultural differences

19
How can Incentives be Improved?
  • Note that incentives high if have user fees
  • Shift funding (and expenditure responsibility) to
    panchayats, where mobility pressures are greater
  • Tie intergovernmental transfers to population
    (or of school kids), providing an incentive to
    compete to attract residents
  • Break down barriers to mobility
  • Ease restrictions on rental markets
  • Ease taxes and restrictions on land sales

20
Why is Deficit so High in India?
  • Some debt appropriate if tax revenue will
    increase in future
  • National deficit Response to rapid turnover of
    party in power? China vs. India or U.S.
  • State and local deficits Soft budget
    constraint?
  • Parallel problems in China
  • No cases of fiscal bankruptcies
  • Intergovernmental grants cover any shortfalls,
    creating incentives to have high debt or poor
    infrastructure

21
What is to be Done?
  • Shift to fiscal transfers based more on formulas,
    e.g. population
  • Restrict use of debt by SL governments to
    capital projects, perhaps with repayment limited
    to resulting revenues, a third reason to have
    user fees
  • Set up clearer legal rules to handle defaults on
    debts of state and local governments

22
Broader Story about Reform Process
  • Pre-reform, controls essential to protect narrow
    tax base
  • Reforms relax controls, improving incentives for
    firms, but undermining tax revenue
  • Pressures force move towards a more neutral tax
    structure
  • Incentives on firms and government improve, but
    revenue likely falls further in short-term
  • Can reform policies survive the resulting fiscal
    pressures?
  • Risk that poor infrastructure undermines growth
  • Risk of default on debt
  • Risk of a populist government undoing reforms
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